Deutsche Bank Investors Get a Scare

An odd kind of bank bond called a CoCo starts to look shaky It’s an instrument “of regulators, by regulators, and for regulators”

Shares in Deutsche Bank tumbled on Feb. 9 to their lowest point since 1992. The biggest thing driving investors’ pessimism: a report from independent research firm CreditSights that said the Frankfurt-based bank might struggle to make its payments next year on contingent convertible bonds, also known as CoCos. Deutsche Bank took the unusual step of saying that it can make payments on the bonds for the next two years, and its shares rallied 4.6 percent on Feb. 10 on reports it might buy back some debt.

The shake-up put a spotlight on CoCos, which are no ordinary bonds. Until recently, the instruments mainly issued by European banks were the best bet on the global credit markets, generating returns of 8 percent in 2015, according to Bank of America Merrill Lynch index data. Their yields average a fat 7 percent when shortterm rates in Europe are negative. But that’s a reward for risk: The bonds allow banks to skip interest payments without defaulting or even convert the bonds into equity in times of financial stress—bad news for investors who had planned to collect their interest and principal.

Now bond markets are paying attention to the downside. In less than six weeks this year, CoCo prices have dropped far enough to wipe out the 2015 gains. European banks are looking much less solid since their previous earnings reports. Deutsche Bank last month posted its first fullyear loss since 2008. Credit Suisse Group— which hasn’t been the focus of the same debt worries—in February reported its biggest quarterly loss since the financial crisis. Investment banking revenue in Europe is shrinking, even as tumbling oil prices, China’s slowdown, and a global market rout are making the banks’ loans and investments look riskier.